By Jeffrey Barg

Published June 1999

• UPMC's battle against Highmark's role in the Allegheny bailout

• React to this article in the Discussion Forum.

PND: Why did Highmark decide to provide financing for the West Penn purchase of the Allegheny hospitals?

KM: The initial reason we got involved in this was that a number of hospital, physician and community leaders came to us and asked us if we could intervene in looking for a solution for the AUH West problems. Highmark has an obligation to do what’s best for its customers in terms of having high quality, affordable health care services. We felt that we had to have some level of healthy competition in the marketplace.

PND: How does financing this deal influence competition in the marketplace?

KM: Without the financing in the AUH West situation, we felt that the entity itself would probably end up in a financially compromised situation, probably in bankruptcy. If that were to happen, a number of things would likely occur. We would have a definite problem with employment of a large number of people in this community, which could be devastating in the short term to the community and certainly could be devastating to those people until they could be placed within the marketplace. And this particular market has suffered. We’re not attracting new business to the market and these people would have a hard time finding employment in the short term. The other thing was that physicians are very concerned about having a stable environment in which to place their patients. And with the entity going into a bankrupt situation, it would create chaos related to who would be the new owner, who would be the new management. Would it be someone from the outside? It’s unknown. We thought that the physicians were in all likelihood going to be displaced from that institution and potentially have some problems with maintaining their practices.

PND: In light of the oversupply of acute care hospital beds in Allegheny County, why would the closure of AUH West be so detrimental to your customers?

KM: I’m not sure that we would disagree with the fact that there may be too many acute care hospital beds in Allegheny County, which is where AUH West is located. But to say that Allegheny General and its affiliate hospitals are the ones that should close is preposterous. If I were the person doing a rationalization in this community those would not be institutions that I would shut down in order to rationalize beds. There are plenty of other institutions that should be targeted if that were the case.

PND: UPMC has noted that the riskiness of this proposed transaction is manifested by the fact that there’s only one offer on the table and no banks have been willing to provide financing for this transaction. How would you respond to that?

KM: I think there’s risk in everything you do in business. I think that West Penn has done a magnificent job in managing through those risks. I think that the likelihood of that institution surviving financially is increased by those activities to date. But I think in every hospital situation in Western PA there’s significant risks right now. Not just in the AUH West venture, but probably every hospital around here. I don’t think UPMC itself is without potential financial risk going forward.

PND: If it is so risky, why risk $125 million of Highmark’s money?

KM: It’s important to maintain healthy competition. Because of the activities of UPMC in the marketplace, we believe we’d end up with a virtual monopoly on the provider side of the business. And without some sort of government intervention and regulation that would be potentially disastrous for the community. At this point in time one could argue whether socialized health care systems are the right answer versus competition. But this country has not blessed socialized health care systems. They don’t have programs in place to regulate them like other countries do. Until we get to that point, that’s not the modus operandi that is acceptable.

PND: Is Highmark’s role in the transaction something that it comes to reluctantly or does it fit into Highmark’s strategic plan in some way?

KM: It fits into our strategic plan to make sure that there is the right level of competition so that we can maximize the quality of care and have some cost focus in the community. That’s what our customers want and that’s what the people in the community need.

PND: UPMC and the Pennsylvania Society of Internal Medicine have sent letters to the U.S. Justice Department, the Federal Trade Commission and the Pennsylvania attorney general citing a number of antitrust concerns they have about Highmark’s role in the proposed transaction. Specifically, they allege that Highmark, the dominant health insurer in western Pa., would attempt to channel patients to West Penn, Allegheny and perhaps the Community Alliance hospitals and to provide them with higher levels of reimbursement than they might otherwise receive to the detriment of the other hospitals and physicians in the area.

KM: Our products are based on providing our customers the things that they want. Most of our customers want access to as many providers as possible while paying reasonable prices. At the current time, our philosophy is to maintain broad networks for broad access. The only reason we would ever go to something that’s less than that is for those customers who aren’t willing to pay the price and those providers who aren’t willing to accept it. If indeed there were channeling to occur, it would only occur because we’re trying to hit some sort of price target that someone wants. We certainly wouldn’t channel to entities that are higher in costs. In effect the statement UPMC made is a bit funny. Why would we want to channel to an entity and then pay them more? If UPMC is afraid of channeling it’s only because their cost structure is so much higher than that entity and business will go there naturally. UPMC has the highest cost and gets the highest payment by far.

If by some chance those customers wanted people to go lower cost institutions, we would put those products together for them. So it’s a customer decision, basically. It has nothing to do with a loan. We advance money to hospitals all the time. We’ve been advancing money based upon anticipating claims costs for years. Not that they’ve been to the magnitude of $125 million. But they’ve been substantial at times. We’re in the business of financing. We finance hospital services. That’s part of what we do along with physician services. So we’re constructing a loan at arms-length fashion with no intent to get into the provider business of owning hospitals. That’s just not necessary. We have plenty of access right now. That’s not to say we wouldn’t do it someday if someone tried to lock us out of the marketplace. If that’s the only alternative we have, obviously we might have to explore that. There is no need to do that right now as long as no one creates a need to do that.

PND: The UPMC filing alleges that Highmark could ultimately have control of the West Penn-Allegheny hospitals.

KM: Here’s an entity raising questions about our activity when they were in here two years ago proposing integrated delivery and financing system. They wanted us to merge all of our assets into their organization and they would be responsible for choosing which providers were in or out of the products. And then we would provide administrative services only if we could beat the standards that were set. Now, that was good back then, but now they’re afraid that we might be doing that with someone else. And in reality we aren’t. And we don’t intend to, because we rejected it back then. We wouldn’t dare do it now because it’s not a good strategy.

PND: But Highmark could have de facto, if not actual, control over the hospitals if, for example, there’s a default on debt repayment schedules.

KM: The problem I have with a lot of this stuff is that this deal hasn’t been concluded yet. We’re still in the due diligence phase. We’re still working out the final terms. What UPMC got their hands on inappropriately is confidential material that was drafted months ago. Those issues are being addressed as we speak right now. And in fact, it’s not our intent to be in a position to take over the institution. The conditions in the terms sheet are simply standard conditions that any lender would put in a terms sheet. Lenders want to protect money they lent to someone and make sure they have the ability to intervene should the management not be doing their fiduciary responsibility or performing according to standards. You’ll see that from any bank, any lender. It’s our intent to protect our investment. If we have to modify that somewhat to satisfy regulators, attorneys general and others, we probably would take a look at that and see if indeed that could happen. It’ll be up to our board as to whether they’ll accept that or reject that. But those conditions weren’t put in as a way to gain control and it’s not a subversive activity. Our primary focus is not to get into the hospital business. If in fact something were occurring where we had to go in and put a consultant in place or if it got even worse and somehow management had to be displaced and board activity had to occur, we would quickly move to rectify that situation and get out of there. If we could find someone else to finance this we’d get out of there. The sooner we can get someone to take over our position in financing, the faster we’ll be out. If we wanted to get into the provider business we wouldn’t do it this way. We’d just go out and buy one. If we wanted to get into the provider business, why wouldn’t we do a deal with UPMC? Why would we do a deal with an entity that’s on the verge of potential bankruptcy? Why wouldn’t we just do the deal with UPMC and become an integrated delivery and financing system?

PND: At times it seems that UPMC’s and Highmark’s positions are the flip side of each other.

KM: I don’t think so, because our position is that we are a health insurer that wants to have a contractual relationship with UPMC and the other providers of health care services. We are not in the provider business. We are not trying to lock any provider out of the marketplace. We are not trying to destroy any provider. In fact we are trying to make sure the systems of health care services in this town are rationalized in a respectable fashion without creating chaos. There’s a big difference. We are not an integrated delivery and financing system nor are we trying to create that. On the other hand, we can’t get a contract with UPMC right now because they refuse to complete the deal. So it’s not that they haven’t been offered a contract, they haven’t signed the contract.

PND: The main sticking point is reimbursement rates?

KM: We’ve been negotiating various aspects of the contract related to reimbursement, related to language and specifically related to only certain products. We’ve made significant progress but we still haven’t concluded a deal. And we also have other products that have yet to be negotiated. And I think it’s very important that you understand we are doing everything we can to effect a relationship with UPMC on a contractual basis. They are a highly respected health care deliverer of services. They are absolutely one of the best in the country. And it’s preposterous for anyone to think that we would not want them in our products. But there’s a price people are willing to pay for that type of service. And they do provide a unique service in this community which we’ve been willing to respect and provide a differential for. From our standpoint, there is no intent to keep UPMC out of our products. We don’t compete with them as a provider. They compete with us as an insurer. There’s a major, major difference there. We have a supplier who’s competing with us, but they don’t have a health insurer who’s competing with them.

PND: As you mentioned before, just a few years ago UPMC was trying to work out some special relationship with Highmark. There was a joint venture on Security Blue. What happened to sour the relationship?

KM: Let me take you back to that point in time. AGH, through its Pyramid system, was looking at a strategy that included an integrated delivery and financing system. They were talking about getting into the insurance business initially. We were not supportive of that. UPMC at the time was willing to contract with us and we began to work closely with them on a number of initiatives because we thought that basically the AGH system and its affiliates through Pyramid were going to directly compete with us. And so that wasn’t acceptable. They then changed their modus operandi. They realized that wasn’t a strategy that was going to be successful and they then simply went about their business doing contractual relationships. At that point because of our nature and the products we have, we kept them in our programs as a provider. We still had a close relationship with UPMC and recognized why that was beneficial for us because of their expertise in a number of areas. So that’s when we made multiple proposals to work with them under the pretense of a contractual arrangement like we had with others, with some special recognition for their special services. We also then set up some research endeavors together, set up some special councils to develop clinical protocols and guidelines, set up some special services for centers of excellence. And they weren’t satisfied with that because we now included the AUH West hospitals in our products and they wanted to have an integrated delivery and financing system. And so we rejected the integrated and financing solution. Another player had proposed that once before and we rejected it. We are not going to be part of that kind of setup. And so they then rejected our proposal of the stronger working relationship under those conditions I explained. And so now we’re down to simply a contractual relationship. We’d love to get closer and do other things, but we have to get through the contract first. On the other hand, we compete aggressively as a health insurer. We can’t get close and have the kind of working relationship that one would have when someone competes with you. You can’t exchange the kind of information you would if you weren’t competing with each other in the marketplace. So with those providers who aren’t competing in that regard, we are probably going to be able to do more things because we can share certain pieces of information as it relates to strategies, as it relates to products, market information, care cost information and the kinds of things we proposed doing with them before they entered into the insurance business.

PND: So, UPMC will be at a disadvantage vis-a-vis other hospitals because they are competing against you in the insurance market?

KM: They will be a disadvantage in terms of the kinds of things we’ll be able to share with them when it relates to market information. They have to do their own market analysis. They’re a competitor in that regard. But we will work with them as a provider with things like utilization information, clinical outcomes as relates to the population they’re accountable for with the physicians they own and manage. And there may be more things once we have a contractual relationship in place. We can’t do anything until we have a contract. We don’t even know if they are going to be in our products next year or if they are going to elect to drop out. We hope not. We think not. It will be detrimental to both of us if that happens. We certainly want them in as a provider.

PND: What is Highmark doing to try to bridge the divide there?

KM: We’re trying to negotiate a contract. The only way to bridge a divide is to settle the contractual terms. Once that’s done, it opens doors for other things to happen. It’s kind of hard to try to work closely with someone who’s trying to kill you in the marketplace. I’m not a psychiatrist, but it seems to me that to really have a close and good working relationship, you can’t do that with someone who’s trying to put you out of business.

PND: How could they put you out of business?

KM: They compete with us. They threaten us publicly in advertising. They threaten us in media. They threaten us with the regulators. They try to thwart every business move we make. I’m not sure it’s because they’re in the insurance business or it’s because of the relationship they want to have with us as a provider. I can’t figure it out.

PND: Is there anything you’d like to add?

KM: This is not a Highmark versus UPMC issue. I will restate over and over again: we have no issue with UPMC as a provider of health care services other than what we have to pay for those services on behalf of our customers. And we want to get that resolved and move forward and have them as providers in all of our products. That’s of primary importance to us. As a provider of health care services in western Pennsylvania, they’re critical. And we believe their institution needs to succeed. Now, outside of that I think the problem that we’re having is that they do compete on the insurance side of the business, which they are permitted to do. And we have to be careful to separate where we act as a competitor to them and where we act on a supplier and contractor basis. From our standpoint we’re trying to separate those things very distinctly. I think they’re confused as to which role they’re playing on which day. Is it UPMC health plan, is it UPMC the hospital or is it the University of Pittsburgh?